Fund directors owe shareholders more

Commentary: Investors deserve proactive, decisive portfolio oversight

BOSTON (MarketWatch) — For the majority of mutual fund investors, the less they know or hear about the fund’s board of directors, the better. After all, what they really want is for the manager to do the job, and the board to stay largely out of the way.

But what investors don’t know — or even want to think about — can hurt them. A new study of director compensation in 2011 shows why.

Typically, fund investors want two things from their boards of directors: They want basic oversight, and they don’t want to pay much for it.

That is typically what they have gotten, too. The study by Management Practice Inc. shows that total board compensation per $1 million being managed in funds is $18.01, a bargain when you consider that — with a 1% expense ratio — a fund is collecting $10,000 per $1 million to cover all of its other expenses.

On a per-director basis, however, some board members are making a pretty nice living. Consider that the top 25 fund companies control roughly three-quarters of all fund assets, and that they have about 270 total directors, according to Management Practice. On average, each of these directors is overseeing $33 billion in assets, which is a lot more money than the typical trustee at a New York Stock Exchange company is in charge of.

Moreover, fund directors are getting paid somewhere between $20,000 and $100,000 for overseeing assets in the $1 billion to $7 billion range; if the average director is overseeing nearly five times that $7 billion figure — you do the math — it’s a nice living.

Indeed, investors have a right to be upset that directors, on the whole, saw their compensation rise by just over 3% in 2011, according to the Management Practice study. Lump all funds together, however, and Lipper Inc. pegged their return was a loss of 1.58%. I believe director compensation should not be rising at a time when investors are not being compensated for taking risks with the fund.

Work detail

What are a director’s main responsibilities? In exchange for those dollars, directors take on a lot of meetings and committee work, and it’s hours of dull stuff for anyone who takes it seriously. Some fund companies have directors meet four times a year, others break it up to have meetings nearly every month but only look at a portion of the fund family at each meeting.

Most fund families have one board for all funds, although the largest complexes typically have one group of directors to oversee stock funds and another for fixed-income and money-market offerings.

Once you have directors making big money, there are a lot of questions. While many directors are classified as “independent,” they don’t have a lot of incentive to act independently if their sole source of income is director’s fees. In cases where they might step in and make a fuss — suggesting, for example, that a firm not renew the management contract of a laggard — most directors simply fall in line with management.

While directors have done a good job of keeping funds away from scandals of their own doing — no directors could have kept a fund out of the markets crisis of 2008 — there are a lot of non-crisis situations that directors could take care of, such as pushing for management changes or fund closures when results warrant it.

That’s challenging for any director who oversees too many funds — my talks with directors make it clear that once you get past 50 funds, there’s a tendency to use the rubber stamp for everything — where they may not have a conflict of interest, but they have a conflict of time and energy.

“Times are different than in the ‘80s and ‘90s, when it was a buy-and-hold market,” said Geoff Bobroff, an industry consultant from East Greenwich, R.I., who serves on a number of fund boards. “We have extensive use of derivatives and other complicated investments, and it’s a board’s job to make sure those things are being used properly. … So far, other than a few very isolated cases, we have not seen the fund industry have a blow-up in terms of a derivatives case, but we will. And it will happen more quickly if directors are too busy to have proper oversight.”

The question is whether directors “get it.” There’s no doubt that the vast majority are working hard and take their responsibilities seriously. But every time directors tighten their ties to fund companies, independence and valuable safeguards are diminished.

Directors would show that they get it by pruning and harvesting funds that deserve to be closed when no one but the fund firm is benefitting or the strategy hasn’t proven viable. Directors show objectivity by pushing fund firms to do right by customers.

If investors could see they have strong directors at times when there is no scandal or crisis, they would trust more completely when the inevitable problems occur. Instead, boards make no fuss and investors basically ignore them and settle for cheap, basic oversight. Shareholders deserve better.

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